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Article
Publication date: 31 December 2019

Vaibhav Lalwani and Madhumita Chakraborty

The purpose of this paper is to compare the performance of various multifactor asset pricing models across ten emerging and developed markets.

Abstract

Purpose

The purpose of this paper is to compare the performance of various multifactor asset pricing models across ten emerging and developed markets.

Design/methodology/approach

The general methodology to test asset pricing models involves regressing test asset returns (left-hand side assets) on pricing factors (right-hand side assets). Then the performance of different models is evaluated based on how well they price multiple test assets together. The parameters used to compare relative performance of different models are their pricing errors (GRS statistic and average absolute intercepts) and explained variation (average adjusted R2).

Findings

The Fama-French five-factor model improves the pricing performance for stocks in Australia, Canada, China and the USA. The pricing in these countries appears to be more integrated. However, the superior performance in these four countries is not consistent across a variety of test assets and the magnitude of reduction in pricing errors vis-à-vis three- or four-factor models is often economically insignificant. For other markets, the parsimonious three-factor model or its four-factor variants appear to be more suitable.

Originality/value

Unlike most asset pricing studies that use test assets based on variables that are already used to construct RHS factors, this study uses test assets that are generally different from RHS sorts. This makes the tests more robust and less biased to be in favour of any multifactor model. Also, most international studies of asset pricing tests use data for different markets and combine them into regions. This study provides the evidence from ten countries separately because prior research has shown that locally constructed factors are more suitable to explain asset prices. Further, this study also tests for the usefulness of adding a quality factor in the existing asset pricing models.

Details

Managerial Finance, vol. 46 no. 3
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 14 March 2016

Ming-Chieh Wang and Jin-Kui Ye

The purpose of this paper is to examine whether the conditionally expected return on size-based portfolios in an emerging market (EM) is determined by the country’s world…

Abstract

Purpose

The purpose of this paper is to examine whether the conditionally expected return on size-based portfolios in an emerging market (EM) is determined by the country’s world risk exposure. The authors analyze the degree of financial integration of 23 emerging equity markets grouped into five size portfolios using the conditional international asset pricing model with both world and domestic market risks. The authors also compare the model’s fitness on the predictability of portfolio returns by using world and EM indices.

Design/methodology/approach

This study investigates whether large-cap stocks are priced globally and whether mid- and small-cap stocks are strongly influenced by domestic risk factors. The authors first examine the predictability of large-, mid-, and small-cap stock portfolio returns by using global and local variables, and next compare the model fitness by using world and EM indices on the prediction of size-based stock returns. Finally, the authors test whether the world price of covariance risk is the same for different portfolios.

Findings

The authors find that the conditional expected returns of large-cap stocks should be priced by global variables. Mid- and small-cap stocks are influenced by domestic variables rather than global variables, and their returns are priced by local residual risks. The test of the conditional asset pricing model shows that the largest stocks have the smallest mean absolute pricing errors (MAE), and their pricing errors are lower in large markets than in small markets. Third, the EM index offers more predictability for the excess returns of mid- and small-cap stocks than the world market index, but the explanatory power of this index does not increase for large-cap stocks.

Originality/value

EMs in the past were known as segment markets, with local risk factors more important than global risk factors, suggesting significant benefits from adding EMs to global portfolios. It would be interesting to examine whether financial integration differs for various firm sizes in the markets.

Details

Managerial Finance, vol. 42 no. 3
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 25 October 2011

Kai‐Magnus Schulte, Tobias Dechant and Wolfgang Schaefers

The purpose of this paper is to investigate the pricing of European real estate equities. The study examines the main drivers of real estate equity returns and determines…

Abstract

Purpose

The purpose of this paper is to investigate the pricing of European real estate equities. The study examines the main drivers of real estate equity returns and determines whether loadings on systematic risk factors – the excess market return, small minus big (SMB), HIGH minus low (HML) – can explain cross‐sectional return differences in unconditional as well as in conditional asset pricing tests.

Design/methodology/approach

The paper draws upon time‐series regressions to investigate determinants of real estate equity returns. Rolling Fama‐French regressions are applied to estimate time‐varying loadings on systematic risk factors. Unconditional as well as conditional monthly Fama‐MacBeth regressions are employed to explain cross‐sectional return variations.

Findings

Systematic risk factors are important drivers of European real estate equity returns. Returns are positively related to the excess market return and to a value factor. A size factor impacts predominantly negatively on real estate returns. The results indicate increasing market integration after the introduction of the Euro. Loadings on systematic risk factors have weak explanatory power in unconditional cross‐section regressions but can explain returns in a conditional framework. Beta – and to a lesser extent the loading on HML – is positively related to returns in up‐markets and negatively in down markets. Equities which load positively on SMB outperform in down markets.

Research limitations/implications

The implementation of a liquidity or a momentum factor could provide further evidence on the pricing of European real estate equities.

Practical implications

The findings could help investors to manage the risk exposure more effectively. Investors should furthermore be able to estimate their cost of equity more precisely and might better be able to pick stocks for time varying investment strategies.

Originality/value

This is the first paper to examine the pricing of real estate equity returns in a pan‐European setting.

Details

Journal of European Real Estate Research, vol. 4 no. 3
Type: Research Article
ISSN: 1753-9269

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Article
Publication date: 26 June 2009

Marie‐Claude Beaulieu, Marie‐Hélène Gagnon and Lynda Khalaf

The purpose of this paper is to examine financial integration across North American stock markets from January 1984 to December 2003.

Abstract

Purpose

The purpose of this paper is to examine financial integration across North American stock markets from January 1984 to December 2003.

Design/methodology/approach

The paper uses an arbitrage pricing theory framework. The risk factors considered are the three Fama and French factors augmented with momentum for both countries as well as their international counterparts. Both the domestic and international four factor models in cross section and test for partial, mild, and strong financial integration are estimated. The domestic and international model are estimated on domestic portfolios and on a subset of Canadian cross listings matched with American stocks.

Findings

Results can be summarized as follows: first, results show stronger evidence of mild rather than partial or strong integration in both domestic portfolios and interlisted stocks. Second, interlisted stocks appear at first glance to be more integrated than the domestic portfolios, but this result can be attributed to the poor explanatory power of the models applied to interlisted stocks. Once the authors rule out the case where the model does not generate statistically important risk premiums for both countries, the evidence of integration is similar in both domestic and interlisted stocks. Third, the domestic and international models have similar explanatory power, although the domestic model performs better with the Canadian interlisted stocks are found.

Originality/value

The results suggest that, in an international context, a portfolio manager is better off using the four factor model as a benchmark in cross sections rather than the single market. Furthermore, if the agency problem described in Karolyi is ignored, Canadian interlisted stocks and Canadian domestic portfolios have the same diversification potential.

Details

International Journal of Managerial Finance, vol. 5 no. 3
Type: Research Article
ISSN: 1743-9132

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Article
Publication date: 29 June 2012

Walter Dolde, Carmelo Giaccotto, Dev R. Mishra and Thomas O'Brien

The purpose of this paper is to assess how much difference it makes for US firms to use the two‐factor ICAPM to estimate their cost of equity instead of a single‐factor CAPM.

Abstract

Purpose

The purpose of this paper is to assess how much difference it makes for US firms to use the two‐factor ICAPM to estimate their cost of equity instead of a single‐factor CAPM.

Design/methodology/approach

For a large sample of US companies, the authors compare the empirical cost of equity estimates of a two‐factor international CAPM with those of the single‐factor domestic CAPM and the single‐factor global CAPM.

Findings

The authors find that the cost of equity estimates of the two‐factor ICAPM are reasonably close to those of either single‐factor model for US firms with low‐to‐moderate foreign exchange exposure; and second, perhaps surprisingly, for US firms with extreme foreign exchange exposure, that the cost of equity estimates of the two‐factor ICAPM tend to be very close to those of the domestic CAPM, and even closer than to those of the single‐factor global CAPM.

Research limitations/implications

The paper's findings might prove useful to academic researchers wanting to resolve the seemingly contradictory empirical results on the pricing of FX risk.

Practical implications

The findings will hopefully help managers decide whether they should go to the trouble of estimating a US firm's cost of equity with the two‐factor international CAPM instead of a traditional single‐factor CAPM.

Originality/value

The paper extends the existing literature by focusing on the two‐factor ICAPM, and finds some new and surprising empirical results.

Content available
Article
Publication date: 18 June 2021

Mehak Jain and Ravi Singla

Asset pricing revolves around the core aspects of risk and expected return. The main objective of the study is to test different asset pricing models for the Indian…

Abstract

Purpose

Asset pricing revolves around the core aspects of risk and expected return. The main objective of the study is to test different asset pricing models for the Indian securities market. This paper aims to analyse whether leverage and liquidity augmented five-factor model performs better than Capital Asset Pricing Model (CAPM), Fama and French three-factor model, leverage augmented four-factor model and liquidity augmented four-factor model.

Design/methodology/approach

The data for the current study comprises records on prices of securities that are part of the Nifty 500 index for a time frame of 14 years, that is, from October 2004 to September 2017 consisting of 183 companies using time series regression.

Findings

The results indicate that the five-factor model performs better than CAPM and the three-factor model. The model outperforms leverage augmented and liquidity augmented four-factor models. The empirical evidence shows that the five-factor model has the highest explanatory power among the entire asset pricing models considered.

Practical implications

The present study bears certain useful implications for various stakeholders including fund managers, investors and academicians.

Originality/value

This study presents a five-factor model containing two additional factors, that is, leverage and liquidity risk along with the Fama-French three-factor model. These factors are expected to give more value to the model in comparison to the Fama-French three-factor model.

Details

Vilakshan - XIMB Journal of Management, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 0973-1954

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Book part
Publication date: 19 November 2012

Makram Bellalah and Sonia Ben Said

Purpose – This chapter studies a two-country model in which firms have the opportunity to invest directly both in home and foreign activities while operating in the…

Abstract

Purpose – This chapter studies a two-country model in which firms have the opportunity to invest directly both in home and foreign activities while operating in the context of imperfectly competitive markets for final goods and services. The model is an extension of Choi (1989).

Methodology approach – The firm is assumed to maximize the expected utility derived from the sequence of present and future levels of wealth, subject to budget constraint. We apply the Hamilton–Jacobi–Bellman approach.

Findings – In this chapter we show that the degree of imperfect competition may be different in the two countries and measured by the elasticity of the demand functions. In this model, we derive the optimal proportion of foreign investment, which is divided into two ratios. The first ratio is a hedging position. The second one is a speculative position.

Originality – Our model shows the role of alternative finance in the presence of differences between investment in two cases, namely, the case of market competition and the case of no market imperfections. This effect is shown by investment proportion and asset pricing relation.

Details

Recent Developments in Alternative Finance: Empirical Assessments and Economic Implications
Type: Book
ISBN: 978-1-78190-399-5

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Article
Publication date: 6 November 2018

Chu-Sheng Tai

The purpose of this paper is to provide empirical evidence on how 1999–2001 dot-com crisis and 2007–2009 subprime crisis affect the gains from international

Abstract

Purpose

The purpose of this paper is to provide empirical evidence on how 1999–2001 dot-com crisis and 2007–2009 subprime crisis affect the gains from international diversification from the perspective of US investors.

Design/methodology/approach

A conditional international CAPM with asymmetric multivariate GARCH-M specification is used to estimate international diversification gains.

Findings

The authors find that over the entire sample period, the average gains from international diversification is statistically significant and about 1.253 percent per year. During the subprime crisis period, the average gains decreases to about 0.567 percent per year, but it increases to 2.829 percent per year during the dot-com crisis.

Research limitations/implications

These research findings although confirm the conjectures that international financial turmoil tends to increase the co-movements among global financial markets, are in contrast to the conjectures that international diversification does not work during the financial crisis as evidence from the dot-com crisis. Therefore, future research on international diversification should not just focus on the correlation among international financial markets and should adopt a fully parameterized asset pricing model to study this research topic.

Practical implications

Given the empirical results found in this paper that international diversification gains may be decreasing or increasing during the financial crisis, as long as investors are not able to predict international financial crises, it is the average gains from international diversification over the longer periods that should encourage investors to diversify, regardless of potentially lower benefits over the shorter periods of time.

Originality/value

The major value of this paper is that although the increase in the conditional correlation during the financial turmoil is consistent with previous studies, the empirical results clearly show that the impact of a financial crisis on the gains from international diversification cannot be solely determined by the correlation between domestic and world stock market returns since the gains also depend on the unsystematic risk from the domestic stock market. Consequently, it is premature for previous studies to conclude that the gain from international diversification is diminishing due to an increasing correlation among international stock markets during the financial crisis.

Details

Managerial Finance, vol. 44 no. 12
Type: Research Article
ISSN: 0307-4358

Keywords

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Article
Publication date: 2 March 2012

Jacques A. Schnabel

The purpose of this paper is to develop a model of international capital market equilibrium where investors exhibit home‐country bias due to their desire to hedge real consumption.

Abstract

Purpose

The purpose of this paper is to develop a model of international capital market equilibrium where investors exhibit home‐country bias due to their desire to hedge real consumption.

Design/methodology/approach

This paper posits a two‐stage process of portfolio choice for the representative investor of a country. In the first step, the investor's benchmark portfolio is determined, whereas in the second step, his optimal portfolio is chosen. The latter portfolio maximizes the expected portfolio rate of return minus the risk tolerance weighted variance of tracking error. The market equilibrium implications of the portfolio optimality conditions are determine via aggregation across all investors and countries.

Findings

A revised security market line is derived that differs from the traditional security market line in terms of vertical intercept, slope, and beta coefficient. It is demonstrated that the derived model may be interpreted as a multi‐country generalization of the Chen‐Boness extension of the capital asset pricing model under uncertain inflation.

Originality/value

This paper presents an innovative application of Roll's tracking portfolio paradigm. Another novel feature is the derivation of the international capital market equilibrium implications of such portfolio choice behaviour.

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Book part
Publication date: 11 December 2006

Wayne Ferson, Darren Kisgen and Tyler Henry

We evaluate the performance of fixed income mutual funds using stochastic discount factors motivated by continuous-time term structure models. Time-aggregation of these…

Abstract

We evaluate the performance of fixed income mutual funds using stochastic discount factors motivated by continuous-time term structure models. Time-aggregation of these models for discrete returns generates new empirical “factors,” and these factors contribute significant explanatory power to the models. We provide a conditional performance evaluation for US fixed income mutual funds, conditioning on a variety of discrete ex-ante characterizations of the states of the economy. During 1985–1999 we find that fixed income funds return less on average than passive benchmarks that do not pay expenses, but not in all economic states. Fixed income funds typically do poorly when short-term interest rates or industrial capacity utilization rates are high, and offer higher returns when quality-related credit spreads are high. We find more heterogeneity across fund styles than across characteristics-based fund groups. Mortgage funds underperform a GNMA index in all economic states. These excess returns are reduced, and typically become insignificant, when we adjust for risk using the models.

Details

Research in Finance
Type: Book
ISBN: 978-1-84950-441-6

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